Association for Public Policy Analysis and Management

With Consent of the Governed: SEC's Formative Years Author(s): Thomas K. McCraw Source: Journal of Policy Analysis and Management, Vol. 1, No. 3 (Spring, 1982), pp. 346-370 Published by: Wiley on behalf of Association for Public Policy Analysis and Management Stable URL: http://www.jstor.org/stable/3324354 . Accessed: 02/10/2013 10:25
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WithConsent the of
Governed:
SEC'sFORMATIVE YEARS

Thomas K. McCraw

The Securities and Exchange Commission, established in 1934, has achieved a uniquely high reputationfor effectiveregulation. TheSEC succeededin largemeasurebecause of the initial strategy developedby its founders.Led by Joseph P. Kennedy,James M. Landis, and William0. Douglas, the SEC sought to restorepublic Abstract confidence in the capital marketsand induce regulatedintereststo help enforcepublic policy. These interestsincludedthe accounting and profession,the organizedsecuritiesexchanges,and the brokers dealersoperatingin the over-the-counter market.In each case, the SEC encouragedthe strengtheningof regulatorystructureswithin the private sector, using its power and influence to promote what later came to be called the "publicuse of private interest." We know too little about the history of regulation in the United States, and most of what we do know has to do with failure. The national policymakers of the 1960s and 1970s, according to James Q. Wilson, were infused with the simple idea that before their time the nation's regulatory commissions had been captured by those whom they would regulate.' National policymakers in the 1980s seem animated by another simple image-that regulatory agencies have preferred to use the weapons of command and control rather than that of incentives, and that such agencies have been prone to reduce efficiency instead of increasing it. Like most other historians, I am reluctant to draw too many "lessons" from the past. Yet no historian can deny Santayana's maxim that those who do not know the past are condemned to repeat it; or even MarkTwain's that although history never repeats itself exactly, sometimes it does rhyme.2I offer this account of the early years of the Securities and Exchange Commission, then, not as a flawless guide or predictive model. Instead I intend it as a possible source of some hypotheses about the ingredients of regulatory success, in particular how agencies may use the interests that are the targets of regulation in promoting the enforcement of public policy.
Journal of Policy Analysis and Management,Vol. 1, No. 3, 346-370 (1982) ? 1982 by the Association for Public Policy Analysis and Management Published by John Wiley & Sons, Inc. CCC0276-8739/82/030346-25$03.50

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SEC's Formative Years

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THE SEC'SREPORT CARDBest known for its supervision of "Wall Street," the SEC also has

courtroom.8

jurisdiction over regional stock exchanges, investment companies, investment advisers, over-the-counter markets, corporate reporting activities, accounting practices, and a number of specialized fields such as public utility holding companies, bankruptcies, and foreign corrupt practices. As an institution the agency has grown from a small office of about 150 employees in 1934-the year of its creation during the New Deal-to a substantial bureaucracy of about 2000. By common agreement the SEC has attracted some of the most talented lawyers and accountants ever to enter public service in the United States. Because of this talent and because it wields powerful sanctions it is not afraid to use, the agency seldom has suffered from problems of credibility and rarely has been accused of "capture" by regulated interests. If corporate managers and their legal advisers do not precisely quake at the mention of the SEC's name, they do have a healthy respect for it. Nearly all executives are familiar with its reporting requirements. These include the disclosure of detailed information about their companies and, if they are sufficiently high-ranking and highly paid officers or directors, disclosure of their own salaries and perquisites. Over the years, one judgment after another has confirmed the SEC's high reputation. In 1940 Sam Rayburn called it "the strongest Commission in the Government."3In the late 1940s the Hoover Commission Report cited the SEC as "an outstanding example of the independent commission at its best."4 In 1971, a survey of regulatory literature found the SEC's standing superior to that of all comparable agencies.5 In a major research project of 1977, the Congressional Research Service of the Library of Congress polled over one thousand members of the regulatory bar in Washington, who "rated the SEC commissioners most positively and the FMC and FTC commissioners most negatively." In the same study, "the SEC also received the most favorable ratings on judgment, technical knowledge, impartiality, legal ability, integrity and hard work."6Even the Reagan transition team had a good word in December 1980: "In comparison with numerous oversized Washington bureaucracies, the SEC, with its 1981 requested budget of $77.2 million, its 2,105 employees and its deserved reputation for integrity and efficiency, appears to be a model government agency."7 Prominent SEC alumni include Justices William O. Douglas and Abe Fortas, Judges Jerome Frank and Gerhard Gesell, Harvard professors Milton Katz, Louis Loss, and Raymond Vernon, and numerous partners of major law firms. So seldom have appellate courts overturned SEC rulings that Judge Learned Hand once called the agency a "sacred cow" of the

The precise meaning of bureaucratic "success" is obscure. On the record, however, there is a presumption that the SEC has succeeded. And my reading of its history is that the SEC's achievement was based in large part on the soundness of its original design and early administration. From the beginning, its

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architects had a coherent strategy, unlike the architects of earlier agencies (Interstate Commerce Commission, Federal Trade Commission, Federal Power Commission) or of later ones (Occupational Safety and Health Administration, Department of Energy). The first four SEC chairmen-Joseph P. Kennedy, James M. Landis, William O. Douglas, and Jerome Frank-were talented regulators who formulated clear plans to implement their strategy. Together with a very able staff, they were willing to spend tedious months and years working out the fine details of the design. Not until 1940, six years after they began, was the structure more or less complete, Their fundamental strategy was to convert a zero-sum game to positive-sum, by exploiting private incentives to public ends in the fashion Charles Schultze later called "the public use of private interest."9 Confronted in the 1930s with a moribund securities market and a demoralized investment community, the SEC's architects worked first to restore and then to modernize a functioning system of capital markets. They pursued this objective by emphasizing the promotion of disclosure more than the punishment of fraud. They administered the strategy wherever possible through third-party institutions rather than through a large corps of federal employees. These third parties were the organized stock exchanges, the accounting profession, and the National Association of Securities Dealers, Inc. The SEC encountered formidable obstacles among industry subgroups and within the agency itself. Sometimes, as in the spectacular fight over the Public Utility Holding Company Act of 1935, the industry's intransigence forced the commission into a combative mode. Though the SEC won this fight handily, it preferred to avoid such an adversary stance. The process by which it did so suggests that contrary to popular belief the United States does have a lively tradition of turning private ends to public purposes through the application of market incentives. Even more clearly, the SEC's experience shows that such application is an arduous task for which a sophisticated knowledge of the industry is indispensable. Without a sense of the industry's structure, its subdivisions, and the points at which regulatory leverage might lie, attempts at promoting enforcement through incentives are likely either to fail outright or to serve only the interests of the industry's strongest members.

THE STRATEGY: setting of the Securities Act of 1933 and the Securities The THE DRAFTING ACTSExchange Act of 1934 was, of course, the Great Depressionl? (see table below). The Securities Act of 1933 required the disclosure of information pertaining to the issuers of new corporate securities (that is, primarily companies issuing new stocks or bonds). All such securities had to be "registered," and the detailed financial data in the

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1929 Volume of Sales on New York Stock Exchange Dow Jones Industrial Average New Corporate Issues of Securities

1932

1.125 billion shares 381 (September) $8.0 billion

0.425 billion 41 (July) $0.325 billion ($0.161 billion in 1933) 23.6 percent (24.9 percent in 1933)

Unemployment (national, all workers)

3.2 percent

required registration statement had to be certified by an independent accountant. This meant that the accounting profession was to be a linchpin of the entire regulatory scheme. The Securities Exchange Act of 1934 mandated similar disclosure by companies with securities already outstanding, through regulation of the New York Stock Exchange and other exchanges. The 1934 act created the SEC and empowered it to change the rules of the exchanges, prohibit stock manipulation, and formulate additional regulations as necessary. Throughout the text, the phrase "in the public interest and for the protection of investors" occurred dozens of times as a rough guide to the intent of the legislation. This act also empowered the Federal Reserve Board to set minimum margin requirements for the purchase of stock on credit. Such margins had been as low as 10 percent in the 1920s; afterward they ranged from 40 to 100 percent. The drafting team included three young lawyers later immortalized in the folklore and historiography of the New Deal: Thomas Corcoran, Benjamin Cohen, and James Landis. All three were proteges of Felix Frankfurter. Corcoran and Cohen had practiced in Wall Street firms. Cohen, in fact, had made a small fortune in trading stocks. Together, the group combined an intimate familiarity with the industry (the special competence of Corcoran and Cohen) with a well-developed knowledge of particular tools of administration (the distinctive strength of Landis).1 Because of his importance for the intellectual history of regulation, the career of James Landis is worth a closer look. A phenomenal student, he had led his class at Mercersburg Academy, Princeton University, and Harvard Law School. As his contemporary David E. Lilienthal recalled, "Of all the intense, brilliant, ambitious young men who made up my contingent at Harvard Law School in the twenties, the fierce, hawk-like Landis was easily

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at the top." In the history of regulation, few names loom larger than Landis'. He served on three federal commissions: the Federal Trade Commission (1933-1934, when it administered the Securities Act), the SEC (1934-1937), and the Civil Aeronautics Board (1946-1947). He wrote two standard works of regulatory scholProcess (1938), one of the most powerful arship: TheAdministrative in favor of regulation ever written; and the Reporton arguments (1960), a merciless dissecRegulatory Agenciesto the President-Elect tion of regulatory failure.'2 The evolution of Landis' academic interests foreshadowed the strategy he later developed at the SEC. After finishing law school, he stayed an extra year to do graduate work with his mentor Frankfurter.13 spent the next year as clerk for Justice Louis D. He Brandeis, then returned to the Harvard faculty. After teaching courses in contracts and labor law, he decided to strike out in a new direction: "I got the theory that we ought to do more with legislation than we were doing ... I felt that legislation itself was a source and should be regarded as a source of law." In Landis' time the study of legislation was a new departure away from the overwhelming pedagogical emphasis on appellate decisions. His pioneering in the field was one reason why Harvard gave him quick tenure (he was only 28 years old), and created a new professorship of legislation.'4 Landis inaugurated a seminar in which he and his students explored a series of difficult issues: the problems of legislative draftsmanship, the rivalries between courts and commissions in construing statutes and discerning legislative intent, the delegation of administrative power, and, above all, the problem of incentives for implementation and enforcement.'5 Admirable legislative intentions, Landis noted, often yielded perverse results. Puzzling over this paradox, he found a critical disjuncture: "The concern of the lawyer with the statute rarely begins earlier than its enactment; the interest of the legislator usually ends at just that point."'6 Accordingly, Landis devoted his energies as a scholar to finding ways of institutionalizing the essential linkages between ends and means, between legislation and administration. As he wrote in 1931, "The legislator must pick his weapons blindly from an armory of whose content he is unaware. The devices are numerous and their uses various. ...Their effectiveness to control one and their ineffectiveness to control others, remains yet to be explored."17 It was exactly this exploration, this quest to match ends with means, that would guide Landis' own draftsmanship of the Securities Act two years later. In 1932 and early 1933, his Harvard seminar had been looking into state "blue sky" statutes, Progressive Era relics which had sought to protect investors against fraudulent securities (pieces of the blue sky). The Great Crash had demonstrated just how inadequate such laws were. And when, during the New Deal's Hundred Days, Franklin D. Roosevelt turned to his old friend Frankfurterfor help in drafting new laws, Frankfurterin turn summoned Landis,

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Cohen, and Corcoran. Landis took a Friday train for what he thought would be a weekend of work in Washington. By the time he returned to Cambridge four years later, he had played the key role in setting and administering the SEC's strategy, had become a national figure (Fortune ran a profile entitled "The Legend of Landis"),18 and had been appointed to succeed Roscoe Pound as dean of the Harvard Law School.* Landis' academic career could hardly have prepared him better for the task at hand in 1933. As the drafting team set about its work, he repeatedly emphasized the implementation side of the problem-the necessity of giving executives, accountants, brokers, lawyers, and bankers a stake in helping to enforce the law. For the securities laws of 1933 and 1934, his quest for the missing link between legislation and administration focused on the production and use of information. The securities acts were to be the quintessential sunshine laws. As Roosevelt's message to Congress in 1933 put it, "This proposal adds to the ancient rule of caveat emptor, the further doctrine, 'let the seller also beware.' It puts the burden of telling the whole truth on the seller."19 Landis took charge of making sure that the information actually materialized. Three provisions of the Securities Act in particular bear the mark of his creativity. The first had to do with subpoena power. Cognizant of the delaying tactics so typical of regulatory proceedings, Landis hit on what he later called "the simple device of making noncompliance with a legitimate subpoena a penal offense." This provision put the burden of proof-that is, of showing cause why the appearance was or was not necessary-not on the commission but on the individual, who now risked jail if he ignored the subpoena.20 A second procedural device was the "cooling-off period." Landis reasoned that the feverish atmosphere characteristic of new stock issues was not conducive to wise investment decisions. Instead, it worked to the advantage of unscrupulous promoters and company insiders who knew in advance when an issue was about to go on the market. A 20-day wait between the submission of registration documents and the first day of sale would address both these problems. At the same time, the cooling-off period would allow regulators to scrutinize the registration statement and prospectus, checking for accuracy and completeness. But this opportunity should have limits. Knowing that the proper timing of stock issues was vital to their success, Landis used the 20 days to put pressure not only on business executives but also on regulators. If the regulators found nothing wrong with the documents, or if they
*From this point forward, Landis drifted slowly downhill. A sometime alcoholic with a deep streak of self-destructiveness, he could not sustain into middle age the round-the-clock work routines of his twenties and thirties. His life ended in poignance and tragedy: in the 1960s, having neglected to file income tax returns for several years (he had put most of the money aside but had failed to send it in), he was sentenced to a 30-day jail term. He died in 1964, a few months after his release.

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simply did not get around to checking them, then the registration would automatically become effective at the end of the 20 days.21 Still another Landis invention was the "stop order." If the regulators discovered anything amiss in the documents during the cooling-off period, they could issue an order suspending the issue. Since a stop order was certain to shatter investor confidence in the security, its issuance meant that the security was dead, often regardless of the results in later hearings or appellate review.22 By thinking about the nature of the securities industry, then, and by drawing on his knowledge of the sanctions available to Congress, Landis had planted valuable tools of enforcement in the basic securities law. Unlike so many other draftsmen of regulatory legislation, he had recognized the importance of matching the sanctions to the problems and of imposing the sanctions at the fulcrums of the industry.23 And in so automating the law's implementation, he had reduced the need for coercion and minimized the size of the enforcement bureaucracy. THE ADMINISTERING Part of the SEC's strategy had been delineated by the statutes. An ACTSequally important part would have to come from their administration. Though the acts were detailed and specific on many topics, the SEC had wide discretion concerning what additional rules it would make, what further legislation it would propose, and what overall approach it would take toward the fulfillment of its mandate. For the commissioners, the basic choice must be governed by the urgency of national economic recovery. Beyond that it must serve the continuing need for a legitimate system to market and trade securities. The possible means toward these goals did not include mindless destruction of the existing institutional arrangements by newly powerful commission appointees. However satisfying that might be, it could hardly promote economic recovery. Administratively, the strategic choice boiled down to whether the SEC would pursue its mandate mostly with its own staff, or whether it would work through the existing institutional structures. The SEC opted for working through these private structures and, where necessary, creating new ones. Landis, conscious of the danger of adverse judicial review, believed such a course to be more in keeping with Anglo-American law than the alternative path of direct coercive action with an army of regulators. Furthermore, as an expert in legal sanctions, Landis remained confident that the commission could hammer out, step by step, a supervisory scheme to minimize the danger of being captured by the industry. The strategy would be presented to accountants, bankers, and brokers as an appealing plan for "self-regulation." Its success would depend on their cooperation and on their behaving as the SEC expected them to behave. The heart of the system would be a careful shaping and bending of the incentive structures of each of the major players to serve the SEC's policies.

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THE ENLISTING The Securities Act of 1933 set forth severe sanctions against ACCOUNTANTS misrepresentation of "material fact" by lawyers, corporate officers, and others involved in preparing the required financial statements. Among the professionals enumerated by the act were the public accountants who worked on such statements routinely. Like most other affected groups, the accountants protested vehemently against the 1933 sanctions. The profession, having suffered historic indignities at the hands of corporate management, now felt itself buffeted from the other side as well. An editorial in the Journal of Accountancy derided an impractical government motivated by "the ambitions of pious theory."24 The putative theorists, of course, were Landis and his fellow draftsmen, whose academic backgrounds offered easy targets. For Landis himself, the more serious problem was how to cut through the hostility and coopt these professionals. His method was to go to the source of the problem and make his strategy explicit. Speaking as an SEC commissioner, Landis told one large gathering of accountants, "we need you as you need us." And in fact the overlap of interests was large.25The profession had labored for years to escape the grip in which corporate management held it. Most accountants wanted to exercise more of that "independence" they claimed to be essential. In its absence, business managers tried to dictate to the auditors, encouraging them to shade or misrepresent the state of a company's financial health. And since accounting was as much art as science, ample room existed for the interpretation of such important accounts as depreciation and asset valuation. When it dawned on the profession that a unique opportunity lay at hand, the hostility to regulation ceased. The American Institute of Accountants formed a Special Committee on Cooperation with the Securities and Exchange Commission, and this group became a permanent liaison. The Journal of Accountancy, editorializing that "the present is the most important epoch in the history of accountancy," now praised the regulators for their conciliatory approach.26 One writer, citing Landis by name, informed the profession that the new legislation was a godsend: "No longer must the public accountant single handed [sic] strive against the prejudiced desire of the officers of clients for what he believes to be fair and correct presentation of facts in the financial statements."27 Landis and his colleagues created an SEC subdivision and put at its head a Chief Accountant. Immediately, this officer became the most important individual regulator of auditing practice in the United States. In 1937, the agency began issuing "Accounting Series Releases" to inform the profession about acceptable methods or procedures. Over the next 45 years, the Chief Accountant sent out nearly 300 of these "ASRs," and they became basic documents in the practice of accounting. In addition, the Commission tried to invigorate the profession's self-regulatory efforts and to promote the perpetual goal of standard methods of accounting in particular industries. It delegated much of its power

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to the accountants' professional associations, but kept up a barrage to stimulate effective action by these groups.28 "In a real sense," wrote one student of accounting regulation, "the Commission's examiners have become accountants' accountants or auditors of audited statements."29Another reported that "in one month" the SEC had set standards "which years of futile committee work within the professional societies have not been able to produce or begin to produce."30 Over the retrospective of a half-century, it is clear that the rigor of SEC regulation has tended to rise and fall with the predilections of the Chief Accountant and of the commissioners. But it is equally clear that measured by what existed prior to the New Deal, and comparatively against systems in other countries, the SEC's strategy has been a qualified success.31 The most palpable evidence of the nature of the strategy has been a striking rise in the number of accountants in the United States. The first stimulus came from the Securities Act, which required that financial statements be attested by "an independent public or certified accountant." Later acts multiplied the number of required statements, and the result was a huge new demand for accounting services. Comparedwith other professions, accounting grew very rapidly during and after the New Deal. It increased by 271 percent betweeen 1930 and 1970, compared with 73 percent for physicians and 71 percent for lawyers.32Small wonder that accountants cooperated enthusiastically with the SEC. TAMING STOCK THE The SEC followed the same method toward the securities exEXCHANGES changes. Landis, who in 1935 succeeded Joseph P. Kennedy as SEC chairman, again made the strategy explicit and delivered the message in person, proffering both the carrot and the stick to his audience: It has always been my thesis that self-government is the most desirable form of government, and whether it be selfgovernment by the exchange or self-government by any other institution, the thesis still holds. I profoundly trust that this experiment will prove successful... So far we have moved quite a bit in [the criminal] field. At the present time there are, I should think, some 140 individuals under indictment. In another speech, Landis emphasized that for stock exchanges, "the central issue of regulation focused upon the area to be allotted to self-government and the conditions of its supervision." And he went on to articulate the commission's goal of a mixed system: Regulation built along these lines welded together existing it made the loyalty of the institution to the broad objectives of government a condition of its continued existence, thus building from within as well as imposing from without.33 self-regulation and direct control by government ... In so doing,

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For the first three years under SEC regulation, the system seemed to be working. The commission shut down 9 exchanges, exempted 6 as of insufficient consequence, and registered 22 as "national securities exchanges." The New York Stock Exchange was by far the most important. It handled over 60 percent of all shares traded on exchanges and over 80 percent as measured by dollar value.34 Its leaders had fought hard in 1934 against the enactment of any legislation that would reduce their power. Under the existing system, the Exchange was ruled by a Governing Committee and led by a president who traditionally continued to do a private securities business in addition to his official duties.35 At the SEC's creation the Exchange president was Richard Whitney, a bond dealer with close ties to J.P. Morgan and Company. Whitney symbolized the aristocratic tone of the Exchange oligarchy. Like Franklin D. Roosevelt, he was a product of Groton and Harvard. He had become something of a folk hero during the Crash of 1929 when, backed by millions from Morgan and other bankers, he had stepped forward in a dramatic bid to halt the frenzied selling. As Exchange president from 1930 to 1935, and as a member of the Governing Committee for even longer, Whitney was the most powerful voice in the organization. Being adamantly opposed to government intrusion, he represented a continual problem for the SEC.36 Landis found Whitney's imperious bearing alternately amusing and annoying. Once when Whitney came to Washington for a conference, Landis took perverse delight in treating him to a 45-cent lunch from the dingy FTCcafeteria, carried on a tray back to Landis' office.37 Whitney's lax enforcement of the new rules, however, could not be laughed away. He continued to run the Exchange as he had in the past, and it became more and more obvious that a nasty showdown with the SEC was inevitable. The only thing that delayed the showdown was the gratifying performance of the stock market, which seemed to be signaling the broad recovery so important to the New Deal. But these gains almost disappeared during the recession of 1937-1938, when the Dow Jones dropped from 194 in March 1937 to just 99 a year later.38 In the midst of the long slide, Landis had departed to take up his duties as dean of Harvard Law School. The new chairman, William O. Douglas, had been about to leave the SEC himself to become dean of Yale Law School. Douglas was known to have less patience than his predecessor toward the procrastinations of the New York Stock Exchange. When he took over in September 1937, Douglas was just under 39 years of age, a blunt, tough-talking Westerner who amused himself by climbing mountains and taking long hikes over rough terrain. He was fully prepared, even eager, to bring the SEC's gun from behind the door and turn it on the likes of Richard Whitney. At the same time, Douglas did not wish to take over the Exchange. Despite his threats to that effect, he was determined that the SEC's strategy of working through the Exchange would survive this new crisis.39

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Within the Exchange, dissident commission brokers had been stirring against the old regime. With the SEC's connivance, these The dissidents engineered a coup that all but toppled Whitney.40 incoming governors then pushed through a series of tough disclosure requirements for Exchange members. And these new reports, quite unexpectedly, turned up irregularities in the affairs of Richard Whitney and Company. The ensuing inquiry led to the incredible revelation that Whitney had been using his clients' assets as collateral for personal loans which he needed to cover losses from his own speculations. He had even used securities owned by the Exchange's Gratuity Fund, which benefited the families of deceased members. When Whitney's tangled affairs were unravelled, it was discovered that between December 1937 and March 1938 he had borrowed more than $27 million in 111 separate loans, in addition to more than $3 million he owed his brother George and other Morgan partners. Whitney was quickly convicted of embezzlement and escorted to Sing Sing Prison. He remained there for three years.41 For Douglas, the scandal was a stroke of incredible good luck: "The Stock Exchange was delivered into my hands."42Whitney's disgrace, coming on top of the disastrous drop in stock prices, swept away further resistance to reform. Though it took many more months to complete the revolution, and numerous threats by Douglas and his colleagues, the New York Stock Exchange cleaned its house. As Douglas wished, it shifted to a more democratic governance and a full-time salaried president. To this office the Exchange named William McChesneyMartin, a 31-year-old commission broker who had been secretary of the ad hoc committee to reorganize the Exchange. The new president led a complete overhaul of the rules and regulations, worked out under the eyes of Douglas and the SEC.43 This process was a microcosm of the SEC's regulatory strategy. For several months, Martin, Douglas, and their lieutenants held meeting after meeting in Washington and New York. As the unpublished records of these long conferences indicate, Douglas used the SEC'sstrong negotiating position to force the Exchange to adopt genuine and thorough alterations. Martin, in turn, adroitly used the specter of direct SEC intervention to win over recalcitrant colleagues. The commission kept the initiative throughout, by nurturing the indeterminacy of the situation and dropping ominous hints about its future intentions. In the end, the carefully orchestrated revolution achieved nearly all the goals Douglas and Martin had sought. Again, by insisting that the Exchange itself propose and adopt the new rules as its own reforms from within, the SEC had used an evanescent crisis to work permanent change.44 ENVELOPING The last element in the SEC's third-party institution-building THE MARKET Securities Exchange Act of 1934. This new legislation, known as

OVER-THE-COUNTER with the passage in 1938 of important amendments to the came

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the "Maloney Act," was written jointly by the commission and the industry. Its target was the over-the-counter market, a loose system of brokers and dealers who traded in government securities, other bonds, and stocks of companies not listed on the organized exchanges. Acting under the Maloney Act, the industry created a new institution-the National Association of Securities Dealers, Inc.-and turned it into an unusual private regulatory agency.45 In the years before the New Deal, the over-the-counter market had harbored some of the sleaziest characters in American business. Well aware of this situation, the legitimate brokers, dealers, and investment bankers had been trying to bring better discipline. Much like the accountants, they had made little progress. But in 1933, government support materialized in the form of the National Industrial Recovery Act. The industry seized this opening. Under the aegis of the NRA, the Investment Bankers Association wrote into its Code of Fair Competition new rules for the over-thecounter business. The code mandated the same kinds of disclosure set forth in the Securities Act. It established regulations for the offering of securities, laid down procedures for the supervision of sales practices, and set up an Investment Bankers Code Committee to administer the system.46 The New York Times called the code "one of the most stringent regulatory documents under the NRA," a judgment which mirrored Wall Street opinion. By September 1934, as the SEC itself was just getting under way, the Investment Bankers Code Committee was already doing business. Its rules were in place, and 2800 firms were displaying the NRA's Blue Eagle emblem.47 Landis watched this activity with much interest. From all he could tell, the over-the-counter market seemed to be putting its house in order much more rapidly than the intransigent New York Stock Exchange. Still, under the legislation of 1933 and 1934, the SEC had some authority to regulate the over-the-counter market itself. And in the fall of 1934, Landis and his colleagues directed the SEC's general counsel to begin drafting an initial set of rules.48 In the meantime the Investment Bankers Code Committee labored on, under several handicaps. The investment banking industry was not coterminous with the over-the-counter market, and the NRA code was only a rudimentary start toward a functioning regulatory system. Then, too, the position of the over-thecounter industry was being weakened by the SEC's policy of strengthening the public's acceptance of the organized securities exchanges. As the prestige of the exchanges revived, the over-thecounter dealers feared a progressive loss of business. Finally, the most serious blow of all came in May 1935, when the Supreme Court ruled the NRA unconstitutional and thereby pulled the rug from under the Investment Bankers Code Committee.49 As if in anticipation of this decision, the SEC in April 1935 had decided to take a more prominent role. Three days before the Supreme Court's historic announcement, Landis had written to the NRA indicating the SEC's willingness to administer the Code.

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As soon as the Court's decision was announced, the SEC asked the Investment Bankers Code Committee not to disband but to stay together and work out, jointly with the SEC, a permanent regulatory system. The code committee thereupon reconstituted itself as the Investment Bankers Conference Committee and began intenAs sive discussions with the SEC.50 before, Landis articulated the SEC's strategy in his speeches: Just as the disciplinary committees of the exchanges have been invaluable to us in our efforts to supervise the activities on the exchanges, similar machinery would seem to be of value for the over-the-counter market. Under a self-imposed discipline it is legislation and regulation.51 Months of close consultation followed, as the SEC and the Investment Bankers ConferenceCommittee drafted and redrafted legislation to implement their goals. The commission aimed at a functional duplication of the SEC-supervised structure now in place for the organized exchanges. The over-the-counter brokers and dealers hoped simply to gain respectability and parity with their competitors in the exchanges. Early in 1938, Senator Frank Maloney (D., Conn.) introduced the bill.52 It provided that the industry could set up, under SEC supervision, an association or group of associations empowered to fine, suspend, or expel those whom it found in violation of rules worked out with the SEC. The act exempted such associations from the antitrust laws, since collective behavior of the type contemplated might otherwise be in restraint of trade.53 The industry responded by creating the National Association of Securities Dealers, Inc. The NASD had a central governing council and fourteen regional offices, a structure very like the SEC's own. The association at once began to regulate maximum dealers' spreads or profits, setting an informal upper limit of 5 percent. It investigated violations both on its own motion and on referrals from the SEC. NASD membership was open by law to all comers, and its governance appears to have been unusually democratic. No brokeror dealer was required to join. Abstainers,however, quickly found themselves at a competitive disadvantage deriving from a clause in the Maloney Act: "The rules of a registered securities association may provide that no member thereof shall deal with any non-member brokeror dealer except at the same prices, for the same commissions or fees, and on the same terms and conditions as are by such members accorded to the general public." In other words, any broker or dealer declining to join missed out on wholesale rates and commissions available only to members. In addition, since all major underwriters joined the NASD, and since its rules kept nonmembers out of underwriting groups, any broker-dealer with underwriting ambitions had to belong. The Maloney Act, then, recapitulated Landis' earlier strategy of draftfrequently possible to lift standards ... more than through

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ing statutes so that they would be as nearly self-implementing as possible.54 The NASD took hybrid form: part regulatory agency, part trade association. The investment bankers and over-the-counter dealers retained the existing Investment Bankers Association as their primary industry group. The NASD, by contrast, assumed the functions and structure of a regulatory agency. At the SEC's insistence it began to develop its own professional staff, which eventually included several hundred examiners and investigators. Over its first forty-odd years, the NASD has freely imposed its sanctions against wrongdoers. It appears to have been more aggressive than either the organized exchanges or the self-policing professions such as law and medicine. Between 1939 and 1960, it expelled 237 firms and suspended, censured, or fined several hundred others. The rigors continued into the next generation as wellSS: Year 1963 1969 1974 1978

Firms Expelled 67 7 97 22

Individuals Expelled 123 19 249 142

Firms Suspended 17 14 55 10

Individuals Suspended 42 21 145 53

The SEC has maintained a close relationship with the NASD. It has seldom overruled a disciplinary action; when such a reversal has occurred, it has more often been on grounds of faulty procedure or excessive harshness than excessive leniency.56 UPSANDDOWNS From the viewpoint of Landis and his colleagues, the system of OF THIRD-PARTY third-party regulation accomplished several goals simultaneously. REGULATION it sharply reduced "government encroachment." If industry First, groups were themselves involved in shaping the regulations, they were in no position to denounce them later or mount constitutional challenges in court. And their everyday commitment to rules written jointly must be stronger than those imposed unilaterally from outside. Second, such a system compelled the industry to think about the need for change. It provided permanent structures of governance that in turn institutionalized the means to achieve change. Again, this placed the industry in an active mode instead of reactive, an initiatory role instead of inhibitory. Third, and in the case of the SEC perhaps most important, third-party structures provided a means of imposing quick, severe sanctions. In the American system of government, when a public agency employs the police power or other organized violence of the state, it assumes the burden of legal due process. If the agency attempts to apply sanctions, it must follow a tedious and hazard-

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ous procedure designed more with an eye to the rights of the accused than for swift corrective or punitive action. In addition, the specter of judicial review, with its potential for endless appellate process, stands in the background as a permanent threat. Landis, because of his academic research into such matters long prior to the New Deal, knew these pitfalls well. Accordingly, from the very first he wrote self-enforcing provisions into the basic legislation. Of course, "self-regulation" or third-party audits were not curealls. Such structures could conceal apathy, chicanery, and self-aggrandizement. This, of course, was what had happened to the New York Stock Exchange before the New Deal. With all its elaborate governing mechanisms, the Exchange was manifestly devoted to the greater enrichment of favored inside groups. Private participation in regulatory enforcement, as a former SEC Chief Accountant put it, requires the "hanging of scalps."57 If any one thing has defeated "self-regulation" even in professions such as law and medicine, it has been a persistent unwillingness to hang scalps. Another potential barrier was the simple refusal of an industry to cooperate. The SEC encountered just such a stone wall when Congress passed the Public Utility Holding Company Act. This legislation of 1935 mandated the reallocation of tens of billions of dollars in assets held by a handful of holding companies. The Act was among the most controversial pieces of legislation in American history, and it produced a violent reaction among utility companies. After losing in Congress, the companies moved immediately into the courts, bringing the heaviest legal artillery they could hire. Though the SEC offered to negotiate, the utilities would have none of it. By 1937, they had entered numerous lawsuits against the SEC and had enlisted such leaders of the bar as John W. Davis, John Foster Dulles, and Dean Acheson. In response to the assault, Landis and Douglas executed a counterattack which ultimately routed the utilities. This litigation consumed four years, and the resolution of the holding company mess five more. But by the late 1940s, the mandate of 1935 reached full implementation, a remarkable achievement.58 In the meantime, the issue cut deeply into the SEC's time, distracting it from other work. The bitterness of the holding company fight typified one of the perennial obstacles to mixed public-private regulatory systems: the personal animus often present on both sides. Landis and Douglas, having been reared in genteel poverty, were sometimes uncomfortable with wealthy businessmen. Like most academics, both chairmen preferred the company of intellectuals. For Landis, the experience of dealing with bankers and brokers not only confirmed this prejudice but made it worse. "Of one thing I am sure," he wrote Frankfurter in 1933, "my name will be 'mud' with our playmates in the street-and that includes both Wall and State. But how truly despicable some of their tactics are. I really thought that they were essentially decent though somewhat mis-

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guided people, but I have my doubts now." In response, Frankfurter urged him to "demobilize your fighting mood" and think objectively, "as though you were still a professor." Yet when Landis followed this advice, he encountered charges of having sold out to Wall Street. The New Republic, then a leader of liberal thought, kept up a tattoo of criticism, urging the SEC to abandon its cooperative attitude and attack the industry frontally. Powerful elements within the SEC staff pressed similar recommendations. But the commission held firm to its strategy of using incentive structures.59 AND POSTSCRIPT After the glory days of the New Deal, the SEC went through a CONCLUSION: period of relative quiet. The exigencies of World War II relegated "LESSONS" securities law to low priority. The commission even relocated from OF REGULATORY HISTORY Washington to Philadelphia to free up space for mobilization agencies. It did not return to the capital until 1948. During both the Truman and Eisenhower administrations, the appointment of undistinguished commissioners tended to dim the SEC's former luster. The same trend was common to almost all agencies during this period, however, and even a diminished SEC retained its primacy among federal commissions.60 Besides, the agency was able to keep many of its best staff members. Consequently, it never drifted into the senescence common to aging bureaucracies. And beginning with the Kennedy administration, the SEC began to recover its old distinction. It attracted not only some first-rate commissioners, but exceptionally able bureau chiefs as well. Some of these staffers, such as Chief Accountant John C. Burton and Chief of Enforcement Stanley Sporkin, carved out national reputations on their own account. Both the New Deal's SEC and the commission of more recent years provide interesting grist for the mill of regulatory theory. Most academic images of agency behavior-models of capture, cartelization, life cycle, public interest, public choice, redistribution, and taxation-offer useful ways to think about the SEC's experience.61 Obvious elements of cartelization inhered in the creation of the National Association of Securities Dealers, Inc. out of the ruins of NRA. Prior to their abolition in the mid-1970s, fixed commissions for exchange brokers exemplified a type of taxation by regulation, a redistribution of income from investors to brokers. A similar redistribution from companies to accountants implied still another type of taxation. And the commission's fundamental strategy of maximizing private participation might suggest that it was captured from the start by regulated interests. Yet none of these models seems to ring quite true for the SEC. There is no shock of recognition as there is when one juxtaposes some of them with other regulatory experiences: the cartelization model with the CAB's regulation of airlines or the ICC'sof trucking; the redistribution model with the FPC's longtime underpricing of natural gas; the taxation model with the cross-subsidization tolerated by the FCCin the telecommunications industry.62

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Perhaps one reason why the SEC does not fit better is that most theories of regulation derive from premises of failure. We have only one well-articulated model of success: the model of public manipulation of private incentives. The SEC, as I have argued in this essay, fits that pattern exceedingly well. It is not my intention to propound an overarching theory of regulatory success or to tease a predictive model out of the SEC's experience. But it remains difficult to resist the tentative conclusion that the agency's history has special meaning for the perennial debates over "regulatory reform." Here was an organization whose institutional forebears-state agencies administering "blue-sky" laws-had placed heavy emphasis on the detection of fraud and the punishment of miscreants. It was an agency set up by such men as James Landis, William O. Douglas, and. other presumed Brandeisians temperamentally inclined to attack big business with guns blazing. It was born in the political hothouse of the 1930s, when the business system in general and the securities industry in particular stood at their historic nadir of public esteem. All of these circumstances pointed to a strategy of punitive retribution. Yet the SEC did not expend the bulk of its resources When it did so, it exploited hunting down and punishing sinners.63 the ensuing publicity to the service of a broader goal. In the same vein, the commission was dominated by lawyers, yet escaped the litigiousness and procedural obsession associated with lawyer control. The SEC's strategists transcended a narrow caseand-controversy mentality and managed to think structurally, in terms of the nature of the industry they were regulating, the ends they wished to achieve, and the means by which the two might be connected. Rather than behaving like a court and eschewing advisory opinions (those betes noirs of conventional judicial practice), the SEC worked out a whole range of informal advisory devices. "No-action letters" and "deficiency letters" became its stock-in-trade, issuing forth by the thousands. The SEC's strategy was not only one of implementation, as the emphasis on means in this essay may have implied. The ends part of the strategy was fundamental. Again it derived from a type of structural, almost macroeconomic perspective often said to be uncharacteristic of lawyers. In 1933, it was not difficult to think in terms of the economy as a whole and to focus on national prosperity and economic growth. This is what the SEC's architects did, Kennedy and Landis in particular. In regulatory initiatives of later years (environmental protection, occupational health and safety, price control of oil and gas), continued prosperity was sometimes taken for granted. Given clarity of objectives, however, it was still a challenging task for the SEC to develop the tools of implementation.64The unpublished minutes of the daily SEC meetings during the 1930s convey the impression of first-rate intellects grappling with a set of problems on the one hand intricate and technical, on the other laden with emotion and high financial stakes. The simple fact that

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the commission met as a group for several hours daily is a measure of the difficulty of the issues. The commission staff was also replete with intellectual heavyweights. Some had been hired specifically for the task of researching complex topics. Douglas, for example, had been brought from Yale initially to direct a year-long study of corporate bankruptcies and reorganizations. And the academic backgrounds of many staff members symbolized the research agenda underlying the agency's evolving strategy. Douglas caught well the essence of the SEC's approach, as he reflected in his autobiography: The commission was an integrated working mechanism unlike anything I had seen before or was to experience again. [Douglas wrote this after having served on the U.S. Supreme Court for almost thirty years.] It had five members, and those five sat in session about eight hours a day, discussing problem after problem. The staff presented questions; sometimes they brought in protesting brokers, dealers, underwriters, corporate officials, or their lawyers. The conclusion seems inescapable that the SEC's success was no happy accident.65 The participation of the industry was crucial. However bright and talented, the commissioners and staff in isolation could not possibly keep abreast of such complex affairs without frequent interaction with brokers, bankers, and the accountants and lawyers who served them. The interaction was difficult to sustain in the midst of so many contrary forces: press accounts of sellout, obstreperous behavior by men like Whitney, staff hostility to the industry and to businessmen in general, conflict of interest, and ex parte considerations. Yet in the end it was clear to the regulators that the industry somehow must be induced to help enforce the law. Landis, Douglas, and their colleagues reached this conclusion because it seemed to be the only foundation for success. To them, "success" meant rescuing the securities industry from corruption so that it could again perform its function of channeling investment into enterprise. The SEC's great achievement was to restore legitimacy to an essential element of the capitalist framework. THOMAS K. McCRAWis a professor at the Graduate School of Business Administration at Harvard University.
NOTES 1. Wilson, James Q., Ed., The Politics of Regulation (New York: Basic Books, 1980), p. 392. See also McCraw, Thomas K., "Regulation in America: A Review Article." Business History Review, 49 (Summer 1975): 159-183. 2. For a commentary on this issue, see May, Ernest R., Lessons of the Past: the Use and Misuse of History in American Foreign Policy (New York: Oxford University Press, 1973). I am indebted to Barry D. Karl for the comment from Mark Twain.

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3. Rayburnto James M. Landis, May 14, 1940, Landis Papers,Manuscript Division, Libraryof Congress, Washington, DC. 4. Loss, Louis, Securities Regulation, 2nd ed. (in 3 Vols.) (Boston: Little, Brown, 1961), p. 1878. 5. Heffron,FlorenceAnn,"TheIndependent Regulatory Commissioners," unpublished Ph.D. dissertation, University of Colorado, 1971, p. 188. 6. U.S. Senate, Committee on Government Operations, 95th Cong., 1st Sess., The RegulatoryAppointmentsProcess (Washington, DC: U.S. GPO, 1977), Vol. I, p. 270. 7. SEC Transition Team, "Final Report," December 22, 1980, Vol. I, p. 9. 8. Quoted in Freeman, Milton V., "A Private Practitioner's View of the Development of the Securities and Exchange Commission." George WashingtonLaw Review,28 (October 1959):23. These judgments of the SEC are typical, but the favorable verdict is not unanimous. For critical views, see Chatov, Robert, "The Collapse of CorporateFinancial Standards Regulation: A Study of SEC-AccountantInteraction," unpublished Ph.D. dissertation (business administration), University of California, Berkeley, 1973; and Phillips, Susan M., and Zecher, J. Richard, The SEC and the Public Interest(Cambridge,MA:MIT Press, 1981). 9. Schultze, Charles L., The Public Use of Private Interest (Washington, DC: The Brookings Institution, 1977). 10. Historical Statistics of the United States (Washington, DC: U.S. GPO, 1975), pp. 135, 1005-1007, 1009; Wyckoff, Peter, Wall Street and the Stock Markets: A Chronology (1644-1971) (Philadelphia: Chilton, 1972), p. 179. 11."The SEC." Fortune, 21 (June 1940): 92, 120, 123-124; Clapper, Raymond, "Felix Frankfurter'sYoung Men." Review of Reviews, 93 (January 1936): 27-29; "Felix Frankfurter."Fortune, 13 (January 1936): 63, 87-88, 90; Schlesinger, Jr., Arthur M., The Coming of the New Deal (Boston: Houghton Mifflin, 1958), pp. 441-445, 456-467; Parrish, Michael E., Securities Regulation and the New Deal (New Haven: Yale University Press, 1970), pp. 42-72. 12. Ritchie, Donald A., James M. Landis: Dean of the Regulators (Cambridge, MA:HarvardUniversity Press, 1980), Chap. 1; Lilienthal, D. E. The Journals of David E. Lilienthal, V: The Harvest Years,1959-1963 (New York:Harper& Row, 1971),p. 494; Landis, J., TheAdministrative Process (New Haven: Yale University Press, 1938);Landis, J., Reporton RegulatoryAgencies to the President-Elect,U.S. Senate Committee on the Judiciary, 86th Cong., 2d Sess. (Washington, DC:U.S. GPO, 1960). 13. The collaboration produced the classic book co-authored by Frankfurter and Landis, The Business of the Supreme Court: A Study in the FederalJudiciarySystem (New York:Macmillan, 1928). 14. Landis manuscript diary, 1928-1929, passim, Landis Papers, Library of Congress; Landis Oral History Memoir, Columbia University Oral History ResearchOffice,pp. 136-137. Dean Roscoe Poundcommented that Landis' rise at the law school was "meteoric, almost unheard of"; see Ritchie, James M. Landis, note 12, p. 35. 15. Landis, J. "The Study of Legislation in Law Schools: An Imaginary Inaugural Lecture."The HarvardGraduates' Magazine,39 (June 1931): 433-442; Landis to Salvatore Galgano, October 3, 1928; Landis to Alpheus T. Mason, May 5, 1930; Landis to Guido Gores, December 10, 1929; Landis manuscript diary, 1928 and 1929, passim, all in Landis Papers, Library of Congress. The most important scholarly result of Landis' efforts during this period was his classic essay, "Statutes and the Sources of Law." In: HarvardLegalEssays Writtenin Honor of and

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Presented to Joseph Henry Beale and Samuel Williston by Their Colleagues and Students (Cambridge, MA: Harvard University Press, 1934), pp. 213-246. 16. Ibid., Landis, The Harvard Graduates' Magazine, p. 437. 17. Ibid., pp. 437-439; see also Landis to Alpheus T. Mason, May 5, 1930, Landis Papers, Library of Congress. 18. Ritchie, James M. Landis, note 12, Chaps. 3 and 4; "The Legend of Landis." Fortune, 10 (August 1934): 44-45. 19. See Schwartz, Bernard, Ed., The Economic Regulation of Business and Industry: A Legislative History of U.S. Regulatory Agencies (New York: Chelsea House, 1973), pp. 2574, 2619. 20. Landis Oral History Memoir, pp. 139-140 and 155 ff.; Landis, J., "The Legislative History of the Securities Act of 1933." George Washington Law Review, 28 (October 1959): 33-38. 21.Ibid. 22. Ibid. 23. On the frequent failure of draftsmen and policymakers to match sanctions to-problems, see Breyer, Stephen, "Analyzing Regulatory Failure: Mismatches, Less Restrictive Alternatives, and Reform." Harvard Law Review, 92 (January 1979): 549-609. 24.Journal of Accountancy, 56 (December 1933): 409; see also Gordon, Spencer, "Accountants and the Securities Act." Journal of Acand Weidenhammer, countancy, 56 (December 1933): 438-451; Robert, "The Accountant and the Securities Act." The Accounting Review, 8 (December 1933): 272-278. 25. Landis' address to the New York State Society of Certified Public Accountants, January 14, 1935, Landis Papers, Harvard Law School. 26. Special Committee on Cooperation with the SEC to Joseph P. Kennedy, July 8, 1935 (a 14-page letter), Landis Papers, Harvard Law School; Journal of Accountancy, 59 (February 1935): 81-82; Journal of Accountancy, 59 (March 1935): 161. 27. Watson, Albert J., "Practice Under the Securities Exchange Act." Journal of Accountancy, 59 (June 1935): 445; see also Scott, DR [sic], "Responsibilities of Accountants in a Changing Economy." The Accounting Review, 14 (December 1939): 399. 28. Smith, C. Aubrey, "Accounting Practice under the Securities and Exchange Commission." The Accounting Review, 10 (December 1935): 325-332; Werntz, William W., "Some Current Problems in Accounting." The Accounting Review, 14 (June 1939): 117-126; Barr, Andrew, "Accounting Research in the Securities and Exchange Commission." The Accounting Review, 14 (March 1940): 89-94; Blough, Carman G., "The Need for Accounting Principles." The Accounting Review, 12 (March 1937); Carey, John L., "Early Encounters Between CPAs and the SEC." The Accounting Historians Journal, 6 (Spring 1979): 29-37. Examples of SEC discussions pertaining to the Chief Accountant's role may be found in SEC minutes of March 17, July 10, and July 31, 1936; June 4 and November 16, 1937; and January 4 and February 12, 1938 (SEC Archives, Washington, DC); and in William Werntz to William O. Douglas, December 17, 1938, Chairman's File, SEC Archives. See also Douglas, W. O., Go East, Young Man: The Early Years (New York: Random House, 1974), pp. 274-276. 29. Greidinger, B. Bernard, Accounting Requirements of the Securities and Exchange Commission (New York: Ronald Press, 1939), p. v. 30. "Accounting Exchange" (editorial). The Accounting Review, 10 (March 1935): 100-102. 31. One of the rigorous periods of oversight was the first 13 years

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(1935-1947), when Carman G. Blough and William Werntz held the office of Chief Accountant. The tenure of Earle C. King and Andrew Barr (1947-1972) was noticeably less rigorous, but the picture changed abruptly with the appointment of John C. Burton, who served from 1972 to 1976. Burton was an aggressive reformer who believed the system needed restructuring. See Coffey, William James, "Governmental Regulations and Professional Pronouncements: A Study of the Securities and Exchange Commission and the American Institute of Certified Public Accountants from 1934 through 1974," Ph.D. dissertation (accounting), New York University, 1976, pp. 222-224 and passim. Coffey concludes that the cooperation has been close, that the Institute's influence has been strong, and that the combined efforts have been salutary though the SEC on occasion might have taken more direct action. See also Barr, Andrew, and Koch, Elmer C., "Accounting and the S.E.C." George Washington Law Review, 28 (October 1959): 176-193. For a dissenting view, see Chatov, Robert, "The Collapse of Corporate Financial Standards Regulation: A Study of SECAccountant Interaction," Ph.D. dissertation (business administration), University of California, Berkeley, 1973. Chatov emphasizes the failures associated with conglomerate mergers in the 1960s, and he is especially provocative in detailing "the sociology of SEC-accountant interaction." 32. Historical Statistics of the United States (Washington, DC: U.S. GPO, 1975), p. 140. These numbers should be taken as rough approximations. The lumping by the Census of "accountants and auditors" confuses the issue, for example; but the growth of the accounting profession as a consequence of SEC policy is widely recognized. 33. The first quoted speech was to the New York Stock Exchange Institute, New York, October 10, 1935; the second to the Swarthmore Club of Philadelphia, February 27, 1937. Copies of both are in the Landis Papers, Harvard Law School. 34. SEC, Report on the Government of Securities Exchanges. U.S. House, 74th Cong., 1st Sess., Document No. 85 (Washington DC: U.S. GPO, 1935); "Douglas Over the Stock Exchange." Fortune, 17 (February 1938): 116, 119, 122, 35. Landis to Sam Rayburn, February 4, 1935, Landis Papers, Harvard Law School; Parrish, Securities Regulation and the New Deal, note 11, Chap. 5. 36. Brooks, John, Once in Golconda: A True Drama of Wall Street, 1920-1938 (New York: Harper & Row, 1969), Chaps. 6-12. 37. Landis Oral History Memoir, note 14, p. 201. 38. Wyckoff, Wall Street and the Stock Markets, note 10, pp. 69-92, 176. 39. Douglas to Roosevelt, April 12, 1939, Roosevelt Papers, Franklin D. Roosevelt Library, Hyde Park, NY; Douglas, Go East, Young Man, note 28, pp. 269-276; "Douglas Over the Stock Exchange." Fortune, 17 (February 1938): 116-126; Parrish, Securities Regulation and the New Deal, note 11, pp. 181-182. 40. Parrish, Securities Regulation and the New Deal, note 11, pp 216-218; Loss, Securities Regulation, note 4, pp. 1209-1211; "The SEC." Fortune, 21 (June 1940): 125-126; SEC minutes, May 26, September 8, and October 30, 1937. The dissidents were led by Paul Shields and E. A. Pierce (of Merrill Lynch, Pierce, Fenner and Smith), who went to Douglas themselves and offered to help clean the house of the Stock Exchange. Shields, a prominent commission broker, had worked earlier with Landis. In a telephone discussion of April 3, 1935, he had predicted that in the impending Exchange election, "That old group

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will be completely annihilated under this scheme. They will be shorn altogether" (memorandum of conversation, Landis Papers, Harvard Law School). 41. Alsop, Joseph, and Kintner, Robert, "The Battle of the Market Place." Saturday Evening Post, 210 (June 25, 1938): 10-11, 78-82; United States of Americabeforethe Securities and Exchange Commission In the Matterof Richard Whitney,et al. (3 Vols.) (Washington, DC: U.S. GPO, 1938); Brooks, Once in Golconda, note 36, pp. 245-287; Douglas to Stephen A. Early (Memorandum on Whitney Report), October 27, 1938, Roosevelt Papers. 42. Douglas, Go East, Young Man, note 28, pp. 269-277; Douglas to Stephen A. Early (Memorandum on Part II of Whitney Report),
October 31, 1938, Chairman's File, SEC Archives. 43. SEC minutes, October 30 and November 23, 1937, February 9, 23, and 24, 1938. The SEC kept close watch on the elections to the Governing Committee of the New York Stock Exchange, familiarizing itself with all candidates and tracking the likely impacts of different mixes of representation on the 48-member board by bond dealers, trading specialists, odd lot dealers, floor brokers, trading specialists who also sold on commission, and commission house brokers, the last named of whom the SEC further separated into five categories: large, medium, small, out of town, and underwriting. See Donald McVickar to Ernest Angell (SEC Regional Administrator for New York), Memorandum, January 4, 1938, Chairman's File, SEC Archives. Exchange President Martin later distinguished himself as Chairman of the Board of Governors of the Federal Reserve System. 44. SEC minutes, March 18, May 17, July 19, August 5, October 8 and 20, December 3, 14, 19, and 22, 1938, and March 10 and 21, June 26, July 14 and 27, August 28 and 29, September 9, 15, 20 and 22, 1939; memoranda of conferences between the SEC and officers of the New York Stock Exchange, May 18, June 3, 9, 16, 17, August 8, December 17, 1938; Milton Katz to Douglas, memorandum, April 13, 1938; Douglas to William McChesney Martin, Jr., December 27, 1938; Martin to Douglas, January 10, 1939; George C. Mathews to Martin, March 20, 1939, all in Chairman's File, SEC Records. See also Roosevelt to Douglas, November 18, 1937; and Douglas to Roosevelt, April 12, 1939, Roosevelt Papers. The process of constant consultation was not new, only more intense, during the Whitney scandal and the Exchange reorganization. See Report of the President for 1936 (New York: Stock Exchange, 1936), pp. 3-4; and for 1937 (New York: Stock Exchange, 1937), pp. 1-5, copies in Baker Library, Harvard University Graduate School of Business Administration. 45. The Maloney Act was named for its sponsor, Senator Frank Maloney (D., Conn.), a friend of Chairman Douglas. On the over-the-counter market and the National Association of Securities Dealers, Inc., see Loss, Securities Regulation, note 4, pp. 1277-1287; White, Marc A., "National Association of Securities Dealers, Inc." George Washington Law Review, 28 (October 1959): 250-265; "Over-the-Counter Trading and the Maloney Act." Yale Law Journal, 48 (February 1939): 633-650; Cherrington, Homer V., "National Association of Securities Dealers." Harvard Business Review, 27 (November 1949): 741 -759; A.R.W., "The NASD-An Unique Experiment in Cooperative Regulation." Virginia Law Review, 46 (December 1960): 1586-1600; Jennings, Richard W., "Self-Regulation in the Securities Industry: The Role of the Securities and Exchange Commission." Law and Contemporary Problems, 29 (Summer 1964): 663-690; Westwood, Howard C., and Howard, Edwin

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G., "Self-Government in the Securities Business." Law and Contemporary Problems, 17 (Summer 1952): 518-544; Parrish, Securities Regulation and the New Deal, note 11, pp. 214-216; and National Association of Securities Dealers, Inc. Manual (Washington, DC: NASD, 1977), pp. 101-117. 46. Code of Fair Competition for Investment Bankers, With a Descriptive Analysis of Its Fair Practice Provisions and a History of Its Preparation (Washington, DC: Investment Bankers Code Committee, 1934). 47. Carosso, Vincent P., Investment Banking in America: A History (Cambridge, MA: Harvard University Press, 1970), pp. 384-388. 48. SEC minutes, October 30, 1934, February 26 and April 10, 1935; Landis to Edward B. Raub, Jr., September 28, 1935, Chairman's File, SEC Archives. 49. Carosso, Investment Banking in America, note 47, pp. 384-389. 50. SEC minutes, April 8, May 3 and 24, June 3, September 19 and 23, November 15, 1935. 51. SEC minutes, January 29 and June 29, 1936; June 10, 1937; Landis to B. Howell Griswold, Jr., September 26, 1935 and June 29, 1936; Landis to Henry H. Hays, October 1, 1936, Chairman's File, SEC Archives; Landis' address before the New England Council, Boston, November 22, 1935, Landis Papers, Harvard Law School. 52. See Commissioner Mathews, George C., "A Discussion of the Maloney Act Program," address before the Investment Bankers Association of America, White Sulphur Springs, WV, October 28, 1938, copy in Baker Library, Harvard University Graduate School of Business Administration. 53. Mathews, George C., "A Discussion of the Maloney Act Program"; SEC minutes, October 11, December 20, 1937, and January 28, February 28, June 28, 1938 all show the SEC's participation in the evolution of over-the-counter regulation. See also William O. Douglas to Roosevelt, January 28 and May 19, 1938 (memoranda); Roosevelt to Douglas, February 1, 1938; Douglas to D. W. Bell, January 25, 1938; Bell to Roosevelt, January 29, 1938, all in Roosevelt Papers; and Milton Katz to Robert Healy (memorandum), March 7, 1938, Chairman's File, SEC Archives. 54. On the NASD, see the citations in note 45 above. On the SEC's role, see SEC minutes, June 18 and 28, July 6 and 30, October 6, November 29, December 19, 1938; December 15, 1939; December 3, 1940; B. Howell Griswold, Jr. to Douglas, February 13, 1939; E. W. Pavenstedt to Ganson Purcell (memorandum), October 23, 1940, Chairman's File, SEC Archives. 55. "Over-the-Counter Trading and the Maloney Act." Yale Law Journal, 48 (February 1939): 646; Loss, Securities Regulation, note 4, pp. 1371-1391; Marc A. White, note 45, p. 265. The statistics on sanctions are from the NASD Annual Reports for 1963 (p. 4), 1969 (p. 5), 1974 (p. 2), and 1978 (p. 9); see also Engel, Louis, How to Buy Stocks, 3rd ed. (Boston: Little, Brown, 1962), quoted in Tyler, Poyntz, Ed., Securities, Exchanges and the SEC (New York: H. W. Wilson, 1965), p. 73. The wide variance in sanctions for some years may reflect periodic laxity, the fluid nature of the industry, or general economic conditions. 56. Cherrington, Homer V., note 45, pp. 756-757; Loss, Securities Regulation, note 4, pp. 1374-1391. 57. Personal interview with John C. Burton, August 1, 1979. 58. SEC, Injunctions in Cases Involving Acts of Congress, Senate Document No. 43, 75th Cong., 1st Sess. (Washington, DC: U.S. GPO, 1937), pp. 6-11; Landis Oral History Memoir, note 14, pp. 213-224; Douglas to

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369

Stephen Early (memorandum), October 13, 1938, Roosevelt Papers; Parrish, Securities Regulation and the New Deal, note 11, pp. 145-178, 219-226; Funigiello, Philip J., Toward a National Power Policy: The New Deal and the Electric Utility Industry, 1933-1941 (Pittsburgh: University of Pittsburgh Press, 1973), Chaps. II-IV. 59. Landis to Frankfurter, December 13, 1933; Frankfurter to Landis, January 10, 1934, Felix Frankfurter Papers, Manuscript Division, Library of Congress. See also Landis to Archibald MacLeish, November 9, 1933; Auville Eager to ?, May 10, 1937; Eager to Landis, May 10, 1937, all in Landis Papers, Harvard Law School; and Ritchie, James M. Landis, note 18, pp. 73-74. 60. For a detailed and well-researched history of the SEC from its origins to the mid- 1970s, see Seligman, Joel, The Transformation of Wall Street: A History of the Securities and Exchange Commission and Modem Corporate Finance (Boston: Houghton Mifflin, forthcoming). On regulatory appointments, see Peterson, Gale Eugene, "President Harry S. Truman and the Independent Regulatory Commissions, 1945-1952," unpublished Ph.D. dissertation (history), University of Maryland, 1973. 61. An enormous literature has accumulated around regulatory theory. For elaborations of these theories and comments on them, see Bernstein, Marver, Regulating Business by Independent Commission (Princeton, NJ: Princeton University Press, 1955); Stigler, George J., The Citizen and the State: Essays on Regulation (Chicago: University of Chicago Press, 1975); Hilton, George W., "The Basic Behavior of Regulatory Commissions." American Economic Review, 62 (May 1972): 47-54; Posner, Richard A., "Theories of Economic Regulation." Bell Journal of Economics and Management Science, 5 (Autumn 1974): 335-358; McCraw, Thomas K., "Regulation in America: A Review Article." Business History Review, 49 (Summer 1975): 159-183; Peltzman, Sam, "Toward a More General Theory of Regulation." Journal of Law and Economics, 19 (August 1976): 211-240; McCraw, Thomas K., "Regulation, Chicago Style." Reviews in American History, 4 (June 1976): 297-303; Owen, Bruce M., and Braeutigam, Ronald, The Regulation Game: Strategic Use of the Administrative Process (Cambridge, MA: Ballinger, 1978), pp. 9-32; Wilson, James Q., Ed., The Politics of Regulation (New York: Basic Books, 1980); and Mitnick, Barry M., The Political Economy of Regulation (New York: Columbia University Press, 1980). 62. See, for example, Jordan, William A., Airline Regulation in America: Effects and Imperfections (Baltimore, MD: The Johns Hopkins Press, 1970); Meyer, John R., et al., The Economics of Competition in the Transportation Industries (Cambridge, MA: Harvard University Press, 1959); and Posner, Richard A., "Taxation by Regulation." Bell Journal of Economics and Management Science, 2 (Spring 1971): 22-50. Compare with Stigler, George J., "Public Regulation of the Securities Market." Journal of Business, 37 (April 1964), reprinted as Chap. 6 of Stigler, George, J., The Citizen and the State; and Schwert, William G., "Public Regulation of National Securities Exchanges: a [negative] Test of the Capture Hypothesis." Bell Journal of Economics, 8 (Spring 1977): 128-150. The most interesting attempt yet to apply regulatory theory to the SEC is Phillips, Susan M., and Zecher, J. Richard, The SEC and the Public Interest (Cambridge, MA: MIT Press, 1981). 63. One of the first five commissioners did wish to emphasize the SEC's punitive powers. This was Ferdinand Pecora, who had conducted the sensational Senate investigation of Wall Street. Pecora soon left the

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commission to become a judge in New York. A number of staff members also departed out of disagreement with the SEC's strategy, including several who were fired. 64. For a modern instance of the difficulties in achieving agreement on incentive structures, see Kelman, Steven, "Economists and the Environmental Muddle." The Public Interest, No. 64 (Summer 1981): 106-123. 65. Douglas, Go East, Young Man, note 28, p. 273. Further speculations about the reasons for the SEC'ssuccess may be found in Ratner, David L., "The SEC: Portrait of the Agency as a Thirty-Seven Year Old." St. John's Law Review,45 (May 1971):583-596; and Freedman,James O., Process and AmericanGovCrisis and Legitimacy:The Administrative ernment(Cambridge:Cambridge University Press, 1978), pp. 97-104.

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